The Forgotten Benefit of the Aussie Dollar

I’m always on the lookout for some good news here at TheMarkets and Money. So let’s kick off the day with some good news for copper.

Yesterday, commodities giant Glencore announced plans to sell assets and reduce debt in order to strengthen its balance sheet. It also announced the suspension of two of its copper mines in Africa, taking around 400,000 tonnes of copper out of the market.

Copper obviously liked the news and spiked 2% at one point in London trade. It closed about 1% higher. It might not seem like much, but on a day when most other commodities fell it was a welcome gain.

But the picture changes when you look at the long term price of copper through the lens of an Aussie producer. When earning revenue based on an Aussie dollar denominated copper price things aren’t necessarily all that bad.

They’re not great, but it’s not as though the copper price is in an endless downward spiral.

The chart below is a five year, weekly chart of copper denominated in Aussie dollars. As you can see, ever since plunging in the latter half of 2011, copper has traded in a broad range. It’s neither bullish nor bearish right now.

Source: StockCharts

To establish a new trend it needs to break out of this range. That could take a while yet.

The message here is that, for Aussie copper producers, things aren’t all that bad. The falling dollar acts as a cushion to falling US dollar prices. This is as it should be.

The stock market price action supports this view. In a recent special Crisis & Opportunity report, which you can read here, I nominated three stocks to buy. One was an Aussie copper producer. Despite the August market turmoil, the stock held up well. It remains in a strong upward trend.

While it’s not all unicorns and rainbows in the commodities sector, it’s not all bad either. There is some good value in the sector. Well managed companies with a strong focus on costs, combined with a falling Aussie dollar supporting revenues, means some stocks will do very well in the next few years.

But right now sentiment remains poor. You can blame China’s deteriorating economic situation for that. Yesterday, the Middle Kingdom announced that it burned through a record amount of treasuries over the past month in attempting to support its currency, the yuan. As Bloomberg reports:

‘China’s foreign-exchange reserves fell by a record last month as the central bank sold dollars to support the yuan after the biggest devaluation in two decades spurred bets on continued weakness.

‘The currency hoard declined by $93.9 billion to $3.56 trillion at the end of August, from $3.65 trillion a month earlier. Economists surveyed by Bloomberg had forecast a median $3.58 trillion. The yuan weakened in offshore trading and 10-year Treasury futures contracts fell after the data.’

As I pointed out last week, China’s capital controls aren’t particularly effective, meaning there is a lot of capital trying to get out of the country. When your capital account is open, it makes it very hard to maintain a fixed exchange rate.

That’s why you saw China devalue its currency over the past month or so. China is trying to defend a weaker exchange rate. Still, they’re losing a lot in the way of foreign exchange reserves in order to stage this defence.

While China still has a massive hoard of reserves, it’s the change that is important to focus on. Because a fall in reserves (even from a high level) represents a drain on liquidity in China’s financial system.

I’ll give you an extreme example. Say someone borrowed US dollars and sold them to buy yuan and invest in a high yielding Chinese ‘shadow-banking’ product.

Due to the negative publicity, the investor gets cold feet and when the investment matures they don’t want to roll it over. They want to get out. So they sell out and now have yuan sitting in a commercial bank account. But they want to get it back out of the country to repay the US dollar loan. They sell the yuan for US dollars and take the money and run.

To supply the US dollars, the central bank must sell its US dollar reserves. In this way falling US dollar reserves also reflect falling deposits of yuan in the Chinese banking system.

That’s not particularly useful when you’re trying to manage a credit bust. China could close up their capital account again — and there are indications that it’s trying to do so.

But one of their economic reform aims is to ‘liberalise the capital account’ and make the yuan a more widely used international currency. They’ve spent years going down this path so they’re not about to renege on it now.

It comes back to the same answer it’s always been…there are no easy choices for China as it adjusts to lower growth and a less commodity intensive growth phase. Every policy choice will be a trade-off.

The reality for Australia is that we will be a loser in China’s transformation. It needn’t be that way. But with a dearth of political leadership and a rent-seeking population, we don’t seem prepared for the structural changes needed to make us prosper again.

Greg Canavan is a Contributing Editor at Markets & Money and Head of Research at Port Phillip Publishing.
He advocates a counter-intuitive investment philosophy based on the old adage that ‘ignorance is bliss’.
Greg says that investing in the ‘Information Age’ means you now have all the information you need. But is it really useful? Much of it is noise, and serves to confuse rather than inform investors.
And, through the process of confirmation bias, you tend to sift the information that you agree with. As a result, you reinforce your biases. This gives you the impression that you know what is going on. But really, you don’t know. No one does. The world is far too complex to understand.
When you accept this, your newfound ignorance becomes a formidable investment weapon. That’s because you’re not a slave to your emotions and biases.
Greg puts this philosophy into action as the Editor of Crisis & Opportunity. He sees opportunities in crises. To find the opportunities, he uses a process called the ‘Fusion Method’, which combines charting analysis with more conventional valuation analysis.
Charting is important because it contains no opinions or emotions. Combine that with traditional stock analysis, and you have a robust stock selection strategy.
With Greg’s help, you can implement a long-term wealth-building strategy into your financial planning, be better prepared for the financial challenges ahead, and stop making the same mistakes that most private investors do every time they buy a stock.
To find out more about Greg’s investing style and his financial worldview, take out a free subscription to Markets & Money here.
And to discover more about Greg’s ‘ignorance is bliss’ investment strategy and the Fusion Method of investing, take out a 30-day trial to his value investing service Crisis & Opportunity here.
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